As part of last year's $7.9 billion preliminary settlement agreement
in the class action against Visa and MasterCard, the card networks
enacted a rule change allowing merchants to surcharge customers up to
4%. Effective Jan. 27, 2013, the optional surcharge is permitted on
credit card transactions in an effort to defuse merchant allegations
that the card brands were violating the Sherman Antitrust Act by
unlawfully fixing interchange fees and rules.

The interchange fee structure of a four-party payment system is predicated on William F. Baxter's seminal piece from the 1983 Journal of Law and Economics.
In this study, Baxter laid out the elements and cost structures for
each of the participants in a four-party payment transaction –
cardholder, issuer, acquirer, and merchant. Essentially stating that
cost flowed principally to the issuer despite interest rates and annual
card fees, Baxter economically justified the merchant (or acquiring) fee
that would flow back to issuers now known as the IRF, issuer
reimbursement fee.

Nearly 40% of Visa and MasterCard merchants are
located in the 10 states that ban surcharging including California, New
York, Florida, Texas and Massachusetts. Despite this and the proposed
surcharging bans recently introduced in more than seven
other state legislatures, it is easy to understand why some might see
this settlement as a triumphant leveling of the competitive playing
field.

"The biggest winners from the settlement are ordinary consumers," according
to Todd Zywicki of George Mason University’s Mercatus Center. "Although
some of the settlement's terms are potentially prone to abuse by
retailers, most notably their new right to impose surcharges on those
who use credit cards, it does affirm the core principle that interchange
fees should be set by free markets and consumer choice rather than by
judges or politicians."

Seemingly unaware of the historical
reasons for creating the no-surcharge rule in the first place, Zywicki
inverts the issue. Consumers are not the winners as the fee was always
embedded into pricing and unfortunately this settlement does nothing to
affirm free-market principles. Mandating no surcharges for the merchant
participants of their early fledgling networks allowed the card brands
to make them an all-or-nothing offer to entice novice cardholders. Had
surcharging been permitted from the beginning, it would have been
difficult to persuade cardholders, and therefore merchants, because
consumers would be incentivized to stick with cash and check payments.

It's
more likely that the card brands didn't want to permit merchants to
offer discounts for cash transactions. Are they preventing card
surcharges or are they preventing cash discounts? Is the glass half-full
or is it half-empty? Maybe a “surcharge” is more palatable for
consumers now if it is described as a discount for cash.

Sometime
during the 1990s, when critical mass was reached and saturation occurred
in the credit card payment networks, the tables were turned. Merchants
no longer had to be persuaded to accept credit cards as a form of
payment. At least in the U.S. and other developed payment markets,
merchants realized the benefits of catering to consumer preference for
cards and they didn't want to suffer by not offering that choice. The
card brands’ acceptance strategy had come full circle, but the
no-surcharging rule had not caught up.

With the all-or-nothing
choice of "accept all payments at the same price or no card processing
at all," once the "nothing" choice started to look relatively
attractive, the card payment networks would be forced to open up. That's
what alternative payment types such as Bitcoin start to permit. The
card-branded networks would begin to see a disadvantage in prohibiting
surcharging because all alternative forms of payment, including cash,
must cross-subsidize the cards. This allows a non-card-accepting
merchant to maintain a significant price advantage over a card-accepting
competitor.

So market forces arguably would have eventually
pushed Visa and MasterCard to permit surcharges. But the settlement,
induced by class action litigation, is worse than superfluous. It is an
unwarranted and unjustified encroachment into the practices of a private
payment company. Just think of the lost capital and lost productivity
of a seven-year, multi-attorney billing festival. Who do you think pays
for that? Furthermore, this bit of central planning via the judicial
system will remove the competitive advantage that alternative
payment-only merchants like Bitcoin Store
have now by forcibly removing the cross-subsidization that other
merchants would have had to follow in accepting bitcoin or alternatives.
If the natural market penalty for cross-subsidization is removed, then
alternative payment-only merchants must begin to accept all payment
types or lose business.

In a free market, payment networks would
compete under their own network rules, not the government's or
regulators’ rules. Sadly, the perceived pricing power referred to in the
antitrust case stems less from alleged collusion among Visa and
MasterCard’s member banks than from the multitude of state-granted
privileges they enjoy that disadvantage new entrants (such as
extraordinary bailouts for favored institutions, the notion of
too-big-to-fail, generous deposit insurance, etc.).

The National Association of Convenience Stores, one of the plaintiffs in the case, rejected the proposed settlement for not going far enough,
saying that the settlement failed "to introduce competition and
transparency into a clearly broken market." While the merchant
lobbyist’s reasons for believing this may not adhere to free market
principles, it accidentally happens to be the correct legal and economic
posture in this case because the settlement is anticompetitive. The
answer, however, is not to coerce transparency and break the market even
further.

Free market competition occurs at the macro
payment system level – not within a given branded system by forcibly
tinkering with the internal fees and surcharges and then declaring a win
for consumers. No one is coerced into using a Visa or MasterCard
product and merchants are not coerced into accepting plastic payments.

The
problem of a payments oligopoly would solve itself because new market
entrants would discover ways to bypass the entrenched networks entirely.

No comments:

Post a Comment

Follow The Monetary Future

Read the Monetary Future

Search the Monetary Future

About Me

I am an e-Money researcher and a Founding Director of the Bitcoin Foundation. My career has included senior influential posts at Sumitomo Bank, VISA, VeriSign, and Hushmail.

"Free-market protagonists, such as Matonis, regard cybercash as better than traditional government-issued or -regulated money, because it is determined by market forces and thus nonpolitical in nature." --Robert Guttmann, Professor of Economics at Hofstra University, in Cybercash: The Coming Era of Electronic Money, 2002

"Matonis is quite correct that the new technology makes easier the use of multiple private currencies." --Mark Bernkopf, Federal Reserve Bank of New York, in "Electronic Cash and Monetary Policy", 1996

"Matonis argues that what is about to happen in the world of money is nothing less than the birth of a new Knowledge Age industry: the development, issuance, and management of private currencies." --Seth Godin in Presenting Digital Cash, 1995